Grant's Almost Daily 9/12,

Higher Oil Prices Coming?

Today, the Department of Energy reported a 5.3 million barrel drawdown of U.S. crude oil inventories for the week, well above the Bloomberg consensus for a 2 million barrel decline. Those bullish inventory figures, along with disruptive potential from the incoming Hurricane Florence and the impact of sanctions on Iran, OPEC’s third largest producer, helped maintain a strong bid in the energy patch as WTI reached $71 and Brent Crude leaped above $80 for the first time since May. 

 

This week’s outsize decline builds on a sharp recent dwindling in domestic stockpiles. According to the Department of Energy, total U.S. crude inventories fell to less than 396 million barrels last week, down more than 15% year-over-year.  That’s despite a steady uptick in domestic output thanks in large part to the shale boom, as DOE production held near its all-time high last week at 10.9 million barrels a day, up 17% year-over-year.

 

Domestic output is set to continue its rise, but perhaps not to the extent that energy bears have counted on.  Thus, the International Energy Agency trimmed its 2019 U.S. production forecast to 11.5 million barrels a day in the September Short Term Energy Outlook, down more than 3% from the 11.86 million barrel estimate in May. 

 

Then too, an anecdotal point from services giant Halliburton Co. indicates that shale activity may not be as bustling as some expected. Last Wednesday, Halliburton CEO Jeff Miller told attendees at a Barclays energy conference: “A decrease in customer urgency. . . has occurred, and we have more white space [in our calendar] than expected.”  Miller likewise observed that: “We are seeing slower than expected activity ramp on several new contracts in the Middle East.”   

 

While investors were taken by surprise, sending Halliburton shares lower by 6% on heavy trading volume, the news corresponds with the bullish thesis laid out by natural resource investors Leigh Goehring and Adam Rozencwajg.  The pair’s second quarter investor letter notes that 2017 global oil discoveries of four billion barrels lagged far behind the 35 billion in global consumption, and they estimate that discoveries have trailed consumption by 210 billion barrels since 2012.  Likewise, Rystad Energy estimates that capital spending in the oil and gas industry will total only $440 billion between 2015 and 2020, just over half of the $875 billion outlay in the 2010 to 2015 period. 

 

Might a looming supply shortfall set the stage for far higher energy prices?  Grant’s put the question to Goehring, who finds that U.S. demand growth is fast outpacing rising domestic production growth, while OPEC struggles to maintain its quota and non-OPEC conventional production remains below its 2010 levels.  

If the U.S. output disappoints, and OPEC’s production can’t hold at [the current 32.7 million barrels a day quota] . . . then we fall into another year of steep deficits that quickly get out of control.    

Energy watchers won’t have to wait too long for an update, as OPEC is scheduled to meet in Algeria later this month, with a press conference scheduled for Sept. 23. For their part, Goehring and Rozencwajg remain highly bullish on energy prices: 

We believe the bull market in oil (ignored thus far every step of the way by the investment community), is set to dramatically accelerate to the upside. Stay long oil and oil-related investments. 

Grant’s, also bullish on oil (see the March 10, 2017 issue for more), continues to concur with the assessment of Goehring and Rozencwajg.